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Brazil: Tribunal considers municipal service tax over complex contracts

Bruno Porto and Mark Conomy of PwC Brazil discuss the Brazilian Supreme Federal Tribunal’s decision confirming that municipal service tax (ISS) can apply over ‘complex contracts’.

Pursuant to the judgment in relation to Acão direta de inconstitucionalidade ADI 3142 dated November 11 2020, the Supreme Federal Tribunal (STF) unanimously rejected the final appeal against the STF judgment dated August 5 2020 (published October 2020), effectively confirming the earlier judgment by the STF that had concluded, by the majority of votes, ISS can apply over complex or mixed contracts. Following the decision, the dispute became final (transitou em julgado) on December 10 2020.

By way of background, the Brazilian Constitution provides municipalities with the power to institute certain taxes, including in relation to services of whatever nature (not otherwise specified in Article 155 of the Constitution), defined in a Complementary Law—this tax is referred to as ISS (imposto sobre serviços).  Subsequently, Complementary Law 116/2003 sets out a list of services to which tax should apply.

Item 3.04 of this list provides lease, sublease, charter, right of passage or permission to use, shared or not, of railroad, highway, posts, cables, ducts and conduits of any nature.

The original STF decision dated August 5 2020 considered the historical controversy in relation to transactions involving arrangements contemplated by Item 3.04, highlighting four key points:

  • Where the arrangement reveals, in essence, a simple ‘obligation to give’ (e.g. mere lease of movable assets), ISS should not be applicable;
  • Where the arrangement reveals an ‘obligation to do’, the levy of ISS is possible;
  • In the case of a mixed or complex arrangement, where it is possible to clearly separate part of the arrangement that should not be subject to ISS (such as an obligation to give), either in relation to its object, or a specific value of financial consideration, this part of the arrangement should not be subject to ISS; and
  • In the case of a mixed or complex arrangement, where such separation is not possible, and the operation falls within the scope defined in a complementary law as a service of any nature (within the terms of the Federal Constitution), the levy of ISS is possible.

The judgment contemplated that even where the lessor (or equivalent) has the obligation to keep things in good condition and to guarantee their good use, this does not transform these situations into a mixed or complex arrangement.

The original STF judgment also considered and dismissed the argument of unconstitutionality of Article 3(1) of the Complementary Law (regarding the municipality of the triggering event) which was based on the argument that in order to comply with the law it would be necessary to create an operational infrastructure in hundreds of municipalities, including opening branches, just to collect ISS in each municipality—violating the principles of proportionality.

On appeal (embargo de declaração), the STF decided that there did not exist any omission, contradiction, obscurity or material error in the judgment, nor an internal conflict with the paragraphs of the Complementary Law or violation of the principles of proportionality or reasonability. Finally, no alteration in the jurisprudence of the Tribunal was identified.  

It considered that mixed or complex contracts are those contracts where obligations of a different nature have been combined within a single contract or transaction. In the case under discussion, this involved the provision of services along with the underlying leasing arrangement.

The judgment of the appeal reiterated that ISS should not apply in relation to transactions contemplated by Item 3.04 where considered in isolation. However, in mixed or complex contracts where it is not possible to clearly segregate the obligations to give and to do—whether it be with the object or concerning the value of the financial consideration specified—the activity may be subject to ISS.

The decision considered the example of the railway lease agreement which provides for the obligation to maintain the railway itself, in a ‘shuffled manner’.  The decision stressed the importance that the application of the tax should be considered in the light of each individual case, having regard to the facts and evidence.

While the judgment deals specifically with the application of ISS, the commentary and analysis regarding complex or mixed contracts involving services may have wider application to other taxes and contributions, and is especially relevant for sectors where complex or mixed contracts are becoming increasingly popular (e.g. technology).

Of specific interest will be the development of the discussion regarding the distinction between situations where the lessor has the obligation to keep things in good condition/state versus the provision of services for the purposes of characterisation of a ‘mixed’ or ‘complex’ contract.

Bruno Porto
Partner, PwC Brazil

Mark Conomy

Director, PwC Brazil

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